February 21, 2007 John M. Reich Director Office of Thrift Supervision 700 G Street, NW Washington, DC 20552 Sheila C. Bair Federal Deposit Insurance Corporation 550 17th Street, NW Washington, DC 20429 Ben S. Bernanke Board of Governors of the Federal Reserve System 20th and Constitution Avenue, NW Washington, DC 20551 John C. Dugan Comptroller of the Currency Office of the Comptroller of the Currency 250 E Street, SW Washington, DC 20219 JoAnn Johnson National Credit Union Administration 1775 Duke Street Alexandria, VA 22314-3428 Neil Milner President and CEO Conference of State Bank Supervisors 1155 Connecticut Ave., 5th Floor Washington, DC 20036-4306 Dear Director Reich, Chairwoman Bair, Bernanke, Comptroller Dugan, Chairwoman Johnson, and Mr. Milner: We commend you for issuing the Guidance on Nontraditional Mortgage Product Risk this past fall. We are hopeful that the guidance will curb some of the abuses associated with high risk, non-traditional loan products. However, despite your recent efforts, we remain concerned that millions of high-risk, unaffordable loans are not covered by the guidance 1
and that massive payment shocks built into these loans could cause a foreclosure crisis that eclipses the displacement caused by Hurricane Katrina. 1 Specifically, subprime hybrid 2-28 and 3-27 adjustable rate mortgages (ARMs) pose the risk of the very severe payment shock that the guidance is intended to prevent. We therefore call upon you to help protect American families by issuing supplementary guidance to clarify that subprime hybrid ARMs are subject to the same underwriting standards as non-traditional mortgages, particularly the requirement of underwriting at the fully-indexed rate. It is as important for subprime borrowers as for prime interest-only or negative amortization borrowers that an institution s analysis of a borrower s repayment capacity should include an evaluation of their ability to repay the debt by final maturity at the fully indexed rate. 2 The severity of the current problem demonstrates that simply reiterating past guidance is not sufficient. We also are asking that the Conference of State Bank Supervisors take similar action for state-regulated entities. Subprime lenders generally make hybrid ARMs without considering whether the borrower can afford the loan past the initial teaser rate, making the loan in effect a twoyear balloon. The resulting acute subprime payment shock is significant, because 18% of all loan originations last year were subprime hybrid ARMs. 3 A mid-year 2006 analysis from Fitch Ratings reported that 2-28 subprime ARMs carried an average built-in payment shock of 29% even if interest rates remained unchanged, 4 and since the London Interbank Offered Rate (LIBOR) increased 1.09% by year-end, the Fitch analysis suggests current payment shock of 48%. Subprime borrowers are particularly ill-suited to bear high payment shock because they are financially stretched already loans are commonly underwritten to 50% to 55% debtto-income ratios. In addition, this nominal payment shock understates the real shock subprime borrowers face for two reasons: (1) in half of the cases, lenders use stated rather than documented income, 5 and stated income has been shown to be exaggerated 90% of 1 Hurricane Katrina caused more than one million people to be displaced in Louisiana and up to several hundred thousand in Mississippi; see Many Displaced By Katrina Turn to Relatives for Shelter, by Blaine Harden and Shankar Vedantam, Washington Post, 9/8/05, p. A1, available at http://www.washingtonpost.com/wp-dyn/content/article/2005/09/07/ar2005090702415_pf.html. A recent study by the Center for Responsible Lending estimates that 2.2 million subprime loans made in recent years have ended or will end in foreclosure (at a rate of 19%). See Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners available at, http://www.responsiblelending.org/pdfs/crl-foreclosure-rprt-1-8.pdf. 2 Interagency Guidance on Nontraditional Mortgage Product Risks at 20. 3 Subprime Mortgage Origination Indicators, Inside B&C Lending (November 10, 2006). 4 Structured Finance: U.S. RMBS Criteria for Subprime Interest-Only ARMs, Fitch Ratings Credit Policy (Oct. 4, 2006). 5 Structured Finance: U.S. Subprime RMBS in Structured Finance CDOs, FITCH RATINGS CREDIT POLICY (August 21, 2006), at 4. 2
the time; 6 and (2) lenders fail to put in escrow borrowers property taxes and hazard insurance, 7 lump sums that subprime borrowers must find a way to pay. 8 It is no wonder that, according to the MBA National Delinquency Survey, subprime loans constitute just 13% of outstanding mortgages but over 60% of foreclosures. 9 A majority of home loans made in 2005 to African-American families were subprime loans, and the overwhelming majority were 2-28s and 3-27s. Forty percent of loans to Latinos were also in this category. 10 By contrast, approximately 80% of home loans made during this time period to white families were prime loans, the market sector in which products covered by the guidance are more common. Unless the underwriting standards from the guidance are clarified to also cover 2-28s and 3-27s, the guidance will afford limited protection in the market sector that disproportionately serves minority borrowers. It is also troubling when older homeowners, often reliant on fixed incomes, are marketed loan products that include terms such as substantial monthly payment increases within 2- to-3 years of closing. These loans are backed not by a projected jump in income, but by the equity in the home -- equity that often represents a lifetime of hard-earned savings. Clarifying the guidance is an important step in the process of protecting all these vulnerable homeowners from current market abuses. We look forward to working with you on this important matter. Thank you for your consideration. Sincerely, AARP Leadership Conference on Civil Rights National Association for the Advancement of Colored People Rainbow/Push ACORN AFL-CIO Center For Responsible Lending Coalition of Community Development Financial Institutions Consumer Action Consumer Federation of America Consumers Union National Association of Consumer Advocates 6 Mortgage Asset Research Institute, Inc., Eighth Periodic Mortgage Fraud Case Report to Mortgage Bankers Association, p. 12, available at http://www.mari-inc.com/pdfs/mba/mba8thcaserpt.pdf (April 2006). 7 See, e.g. B&C Escrow Rate Called Low, Mortgage Servicing News Bulletin (February 23, 2005). 8 Partnership Lessons and Results: Three Year Final Report, p. 31 Home Ownership Preservation Initiative, (July 17, 2006) at www.nhschicago.org/downloads/82hopi3yearreport_jul17-06.pdf. 9 Mortgage Bankers Association, National Delinquency Survey Third Quarter 2006. 10 Based on 2005 data submitted under the Home Mortgage Disclosure Act. 3
National Consumer Law Center (On behalf of its low-income clients) National Community Reinvestment Coalition National Fair Housing Alliance National Lawyers Committee for Civil Rights Under Law National NeighborWorks Association Opportunity Finance Network U.S. PIRG African American Caucus of the NC Democratic Party Arkansans Against Abusive Payday Lending Appalachian Community Enterprises Boston Community Capital Capital District Community Loan Fund CASA of Oregon Cascadia Revolving Fund California Reinvestment Coalition Capital Alliance. Chautauqua Home Rehabilitation and Improvement Corporation Clearinghouse CDFI Coalition on Homelessness & Housing in Ohio Coastal Enterprises, Inc. Colorado Enterprise Fund Community Action Committee of the Lehigh Valley Community Legal Services in East Palo Alto Community Development Venture Community Enterprise Investments, Inc. (FL) Covenant Community Capital, Houston TX Dayton Community Reinvestment Coalition Delaware Community Reinvestment Action Council, Inc. (DE) Double Eleven Credit Union Economic Opportunities Fund Edgemont Neighborhood Coalition Inc Enterprise Corporation of the Delta FAHE Inc., KY Federation of Appalachian Housing Enterprises, Inc. Funding Partners for Housing Solutions Greenlining Institute Housing Committee of the NC Conference of the NAACP Jewish Community Action Lenders for Community Development Leviticus 25:23 Alternative Fund Long Island Housing Services, Inc. Low Income Investment Fund MaineStream Finance Maui Economic Opportunity Business Development Corporation The Native American Lending Group, Inc. National Association of Human Rights Workers - 4
National Community Investment Fund North Carolina Fair Housing Center - New Jersey Citizen Action (NJ) New York Association for New Americans Neighborhood Economic Development Advocacy Project (NEDAP), NY North Carolina Community Development Initiative Northeast Entrepreneur Fund Northeast South Dakota Community Action Program (NESDCAP) Northeast South Dakota Economic Corporation Northland Foundation Oregon Community Credit Union Partners for the Common Good Pittsburgh Community Reinvestment Group PPEP MicroBusiness and Housing Development Corporation RNA Community Builders The Reinvestment Fund SC Appleseed Legal Justice Center. Scott County Housing Council (IA) Southern Financial Partners United Neighborhood Centers Virginia Partnership to Encourage Responsible Lending (VaPERL) Ed Gramlich,*The Urban Institute Patricia A. McCoy,George J. & Helen M. England Professor of Law,*University of Connecticut School of Law *- organization listed for identification purposes only Northwest Indiana Community Reinvestment Alliance (IN) 5